HFT curbs to hit market makers – academic research

Proposed rules to curb high-frequency trading (HFT) in European regulation will harm market making operations more than predatory price
arbitrage strategies, new research has shown.

The academic research examined data from Nasdaq OMX Stockholm, and
found that HFT increased market stability and provided liquidity, but that both of these would be affected by curbs aiming to limit HFT in proposed European regulation
including MiFID II and the financial transaction tax.

“A majority of the HFT volume and more than
80% of HFT limit order submissions are associated with market making
strategies. Thus, any policy aimed at limiting the scope of HFT activity as a
whole would primarily hit market making strategies,” the report states, adding
that the implementation of order-to-trade ratios (OTR) could be particularly
harmful to HFT market makers.

“High order‐to‐trade ratios associated with HFT is
primarily a market-making phenomenon. In August, 2011, market makers had 40%
higher order‐to‐trade ratios than opportunistic HFTs,” read the report, adding that OTRs would further increase for market makers if minimum tick sizes
were imposed across trading venues, a feature of the European Parliament’s
Economic and Monetary Affairs Committee (ECON) MiFID II
version voted on by MEPs last month.

“Our results show that
insofar such regulations would increase tick sizes, market making HFTs would
increase their activity whereas opportunistic HFTs would decrease their
activity.”

ECON has also proposed imposing a 500 millisecond resting period for all orders and banning maker-taker pricing, a key tool used by HFT firms to make their strategies profitable.

The report, titled ‘The diversity
of high frequency traders’, was published by Björn Hagströmer Lars Nordén from the Stockholm University School of
Business and attempted to differentiate market making HFT strategies from
predatory strategies.

“Our results indicate that, as a group, the
opportunistic HFTs contribute to market quality,” the report reads. The publication
of the report comes weeks before an October plenary vote
on ECON’s version of MiFD II is due. MEPs will then be required to reconcile
their amendments with a version of the directive proposed by the Council of the
European Union, with input from the European Commission. The implementation of
MiFID II is expected in 2014-15.